6. The implementation of blockchain
6.3 Design of the blockchain network
6.3.1 Regulators and Compliance
Today, regulatory and compliance reporting such as Electronic Data Interchange (EDI), Anti-Money Laundering (AML), and Financial Action Task Force (FATF) ensures sufficient payment transparency and keeps high-risk payments under surveillance. Regulation has four main
objectives: Securing financial stability, conduct and fairness, prudential regulation, and
competition and market development (Arner et al., 2015). Combining blockchain technology and data analytics, could facilitate real-time screening in suspicious transaction activities. By
changing the whole payment infrastructure, there will be challenges maintaining compliance
with regulators. A solution will be to include data analytics (big data) as an additional data layer of the blockchain network. In this data layer, details of the transactions within the blockchain will be registered. This big data environment with all the details of transactions will be available for compliance and regulation. For it to be possible, the registered details of the banks within the blockchain network must also be available. Figure 6.2 below, shows how transparency will be achieved.
Figure 6.2: Framework for a collaborative approach to regulatory reporting (Ravishankar, 2018).
6.3.2 Key benefits of a data layer
1. Organized: Data can be easily be subdivided by country, region, bank and date making it simple to have a complete overview of all data. Consequently, compliance and regulatory measures will be simple to conduct. This data environment will serve as a crucial source of information for compliance, regulatory and investigation purposes.
2. Efficient: Information such as customer, registration, transaction and bank details can automatically be placed in the big data environment. Unhashing the transaction details from the “blocks” will also be possible. This will make a much more efficient distribution of information and (Shah et al., 2017):
3. Business Intelligence (BI): Access to data for compliance, regulators and other departments will give them the ability to conduct analysis with a more transparent approach. Much more data will be available, as most data will be available on the added data layer (Ravishankar, 2018).
6.4 Challenges and Risks
There are several challenges and risks to consider if the implementation of blockchain
technology should completed. Having stated that for blockchain to be implemented, there must be collaboration between banks. Moreover, implementation can only be as efficient as the slowest member (Fintech Futures, 2018). Delays are bound to occur as more banks are
responsible for a correct method of the implementation of blockchain. Banks must also accept higher operational cost in the beginning. As the motivation of the system is to reduce cost for both banks and customers, banks run the risk of being responsible for most of the cost affiliated with implementation and operational costs. Considering overall cost of maintenance, using bitcoin as an example, where computing power and electricity cost has increased dramatically.
Banks must design the blockchain network to where it will bring economics of scale.
The implementation of blockchain must be considered an investment. Moreover, banks must have a clear overview of what cost are affiliated with the implementation and operation of the system. Banks run the risk of having long payback periods. A full understanding of what costs they will be subjected to must be determined (Shah et al., 2017). Also, as the application of blockchain will require significant overhaul of existing systems in place. Banks must carefully strategize the transition. There needs to be a consortium based approach as all stakeholders agree on the same system designs (Shah et al., 2017). There needs to be thorough education to
minimize the risk of ineffective implementation of the blockchain technology.
There will also a substation risk concerning cyber security. Managing security within a private technological infrastructure is a lot easier than what a shared technological infrastructure
(Fintech Futures, 2018). Blockchain technology is a shared infrastructure. The extent of exposure
to cyber-attacks are unknown. The risk of external and internal cyber-attacks must be determined.
There are also questioned about how the concept of reversing mistakes on the blockchain. There might be an incident where there are mistakes made, either a transaction or identity information etc. Blockchain is set up to be tamper proof. This means that it is impossible to reverse if there already was a consensus about the new information being valid. A new block is created and theoretically irreversible (Fintech Futures, 2018). Will it be possible to reverse if the information provided is wrong?
Lastly, change management post implementation is another challenge for participating banks. As all participants need to agree on the change, implementing blockchain may be more challenging as there will be disagreements on how the operational aspects of the system will be handled (Fintech Futures, 2018).
6.5 Current standpoint of blockchain with banks today
There is obviously a long way to go before utilization of blockchain within transfer will be implemented. To better understand the standpoint of banks of the technologies today, a short presentation of blockchain entry into the banking world will be provided.
There is about 90% of banking executives that state that they are studying the potential of
blockchain technology. 40% of banks are still at the exploration phase, meaning that they are still considering where the implementation would benefit the banking industry. Approximately 30%
are pursuing proof of concept (PoC). It is believed that the most likely implementation of
blockchain technology will be within intra-bank cross border payments, but also inter-bank cross border payments are regarded as a possible destination of the technology (Consultancy.UK, 2016). The banking industry is also studying several benefits of the technology. Research show banks consider lower frictional cost, lower administrative cost, shorter settlement time, error reduction and new revenue opportunities to be promising benefits.
Fintech companies are benefiting from banks interest in the blockchain technology, Companies such as Ripple and R3 are already working with banks developing blockchain based systems for cross border payments and regulatory factors that include in such payments.
Ripple, which also has their own cryptocurrency, are considered to be a fintech company. As early as May 2016, Santander bank announced they have developed an application to facilitate cross-border payments using Ripple’s blockchain technology. The application is available on mobiles in Spain, UK, Brazil and Poland. Expecting to expand to more European countries. Latin America and Asia soon (Ngetich, 2018). This solution is for Santander customers only, meaning a solution for intra-bank cross border payments.
R3 is another fintech company that has partnered with 39 financial firms testing R3’s Know Your Customer (KYC) application, which is based on blockchain technology. R3 completed more than 300 transaction between 19 countries. The customers could request KYC data, while clients could grant or revoke access (Partz, 2018). Their goal was to speed up process of
verifying customer's identity for financial transactions both domestically and internationally.
Ripple published a paper in 2016 about potential savings for banks when implementing their blockchain technology with cross-border payments. An estimate of 33% cost reduction is presented. Moreover, Ripple estimates a one-time payment of 10 million USD for the
implementation and suggesting the payback period will be about 11 months. They also state that it will depend on a banks size (Ripple, 2018)
.
Another important entrant in the blockchain world is Swift. Swift are also testing how
blockchain technology might improve their current operations. They are regarded as Ripple’s biggest competitor within cross border payments (Arnold, 2018). Newly, Swift implemented the use of Global payment initiative, which is used by only 165 banks worldwide. This technology, previously discussed is not based on blockchain. Even though it has reduced frictions in cross border payments, Swift are looking into how blockchain may benefit their operations. Swift have stated that they are sceptic of blockchains benefits.
Several other fintech companies are pursuing the opportunities arising in cross border payments and also other areas with banking. It is clear that some headway has been made, but in regards to intra- bank cross-border payments, there is still no definite solution being proposed. Starting with inter-bank cross border payments seems to be banks first priority as it is easier to control more factors included in the implementation.
7. Conclusion
Bitcoin, instead of treating traditional monetary systems, has developed a technology that will benefit banks and other financial institutions in the future to come. Cryptocurrencies does not have government backing, causing bitcoins to not being able to penetrate present monetary systems. However, money transfer operators such as PayPal, Western Union and Transferwise are direct threats to banks cross border payment segment, as they provide customers with enhanced value propositions.
Having presented a method and benefits for banks to utilize the blockchain technology, it is clear that it will benefit banks involvement in the cross-border payment segment. A digital ledger provided by the blockchain technology will eliminate much friction that is present in the payment chain, and thereby increasing customer value propositions. Also, a study by Ripple, suggested severe cost reduction in regards to banking operations.
The main challenge of the implementation of blockchain technology is providing a standardized system that can be utilized globally. Much of the payment chain frictions are caused by countries having different messaging and account systems. Therefore, it is crucial that when implementing blockchain, the system must be structured to suit all banks involved. Banks and other financial institution responsible for the implementation of the technology must educate themselves to have a complete overview of its risks. Security is a major risk, as no one really understand the
technology implications, banks must construct proof of work before implementing blockchain.
In conclusion, I strongly believe that banks cross border payment segment will be able to provide customers and themselves, with enhanced value propositions by utilizing blockchain technology.
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